Your First Investment Property

I read an article today that stated the total stock market return for the next ten years will be lower than it was for the last 10 years. The rate of return in this article was set at about 3%. The average stock market return over time is about 7%. What do you do when your 7% return drops to 3%?

You look for other ways to make money. Investing in real estate has always been a way for some to make additional current income while building equity for the future. Understanding that you would not be reading this article if you were not already interested in investing in real estate, enough of trying to sell you on this.

Residential Rental Properties

This article will only cover investment in residential type properties e.g. Condos, single family homes etc. I will not get into office buildings, commercial developments etc. These properties require a bit more expertise and I do not recommend them for the first time investor. For purposes of this article we stick to places that people live in.

Before I get further in to this topic, let me explain my experience. I started investing in real estate as a bit of an accident. I bought a condo years ago ahead of the first California real estate slump caused by the Japanese stock market collapse. Turns out that the Japanese were heavy investors in California real estate and they dumped property just to get any cash they could as fast as they could.

But I digress, actually the run up to the slump was similar to the one about 12 years ago. Prices were sky high. I moved back to California with my company and I simply could not afford a house. We sold our new 3,500 sq ft home in Washington State and bought a 940 sq ft condo with one garage. What a let down. But, it was our condo and were were not renting.

Real Estate Investing Was an Accident

We decided a couple of years later to sell the condo and buy a new home. New home prices had dropped and I later found that so did my Condo. I listed my condo and I had to keep readjusting it down. Finally I told the real estate agent that I had had enough and would rent it. I was able to buy the new home and rent the condo at the same time.

The rental thing worked well. The first year I did just a little better than break even so I had an opportunity to buy a bank owned condo and scooped it up for a rental. That worked out so well, when we decided to once again buy a new home, I rented my existing home. Now I was a real estate baron. Three rental properties all making money.

That was my start, I managed all three properties and have never regretted it. Perhaps its was what I had learned from my grandfather who owned rental houses and second mortgages. He did very well supplementing his retirement income.

Now back to you and the reason why you are reading this article. I will provide some suggestions here from my personal experience and give you reasons for those suggestions. Keep in mind that should you use any of my suggestions that you are doing so with this caveat: It’s your decision and yours alone to buy rental property. While the is a form of disclaimer, the purpose is to explain that while something worked for me, it may not work for you.

The next lesson, you can buy hundreds of books by people who have bought and sold properties and are making more money selling the knowledge than they probably ever did buying and selling property. What I have to impart is just a bit of the lore surrounding property ownership and management.

This is not about Flipping

If you want to flip properties, this article will probably not provide sufficient information. Flipping is a specialty that I have decided to avoid. Mind you, I have no issues with risk, just buying a rental property is risk. Flipping is has far more risk and stress. If flipping is your deal, go for it. Mine is slow accumulation of wealth by implementing a strategy that includes buy, rent and hold.

Now that the flipping thing is out of the way, let’s get into your first property investment. Starting with what type of property is best for you. Condos, single family homes, duplexes, four plex units and larger multi-family buildings and complexes.

The following is a quick explanation of each type of property:

• Condos – Single family condominium units are part of planned unit developments. Generally there are multiple units in each building and multiple buildings in the development. Unit sizes vary between 800-1,600 square feet, from one to three bedrooms as a rule. Condos are part of a condo owners association which is generally managed by a third party. There are “CCR;s”, conditions, convenents and restrictions that apply to all units regardless of who is living in the unit. These usually prevent leases for rental of less than one year. Fees charged to owners usually but not always include water, sewer, trash, insurance for the exterior, maintenance of common areas and recreational facilities e.g. pool.

• Single family home – These are located all over, some are custom, others are part of planned developments where all homes look slimilar and the square footage from the smallest to the largest does not vary by a large degree. Some single family home are located in HOA developments, older homes are typically not in HOA’s. Even if a SFH is not in an HOA, there are community standards usually enforced by the City code enforcement department e.g. no parking on lawns. Some cities forbid short term rentals. While it is true that SFH’s in general provide a bit more flexibility for rentals, there are still rules that tenants have to abide by.

• Duplex – Two homes in one building. These are usually built in areas where there are other duplexes as well and perhaps in their own development. Basically, there are two front and back doors, the building is split in half. Both units share a common roof and structure. There may be an HOA type arrangement because the owners have to agree when its time for example for a roof that they both have to contribute to it. Some duplexes are listed a single owner building. Often duplexes are rented. These make a good rental because there is a single maintenance cost with two sources of income.

• Fourplex – this is a building with four individual units. I owned four plexes that had three units in a single building with a separate single family home that was attached by a garage to the other. Unique properties and are good rentals. The four flex offers again, a single property to maintain with four income streams. Some cities may allow short term rentals at a four plex. This is the largest size of residential property that a residential loan can be obtained for. Five or more units in a single building are considered commercial and loans usually have higher interest rates.

• Muiti-family Units (5+) – These as mentioned are commercial properties. They may be in a single building or in multiple buildings son the same property. They can be very profitable but owning them brings you into contact with federal, state and local regulations that can be onerous for property owners. Some larger complexes are managed by a live in manager.

Now that you are aware of the various types of rental properties the discussion will focus on the search and acquisition of your first property. While I started with a condo in my personal portfolio, we will start instead with a single family home and than talk a bit about condo’s. This discussion will avoid other types of properties as they are just a bit more complex than SFH and condos which are the best to start with.

To start, it’s best to bullet point the items that you will need to consider:

• You have decided to buy a SFH
• How will you hold title on your property?
• What is your current income goal e.g. X% cash on cash return or X%ROI or other metric.
• Who will manage your property?
• What is your budget for the purchase and closing costs?
• What is your budget for making minor repairs, painting etc.?
• Select an area for the purchase
• Gather information about rents and property costs in the selected area
• Run numbers through the investment calculator
• Narrow down homes that meet your investment requirements
• Find a Realtor in the area with experience in rental property
• Ask your Realtor for a property manager if you need one
• Determine what the property manager charges if you need one
• Look at potential properties and make a decision
• Work with the Realtor to make an offer.
• Obtain from the owners copies of rental agreements and other information e.g. are they late on rent.
• Put in an offer, close escrow get keys.

There is more work ahead of you, I stopped the checklist at this point because everything above relates to planning. Managing is another discussion which we will get into but first a brief explanation of all of the items above.

Go to another part of the country to find properties that you can buy for a reasonable price and rent for a profit.

A frequently asked question on Quora where I am a frequent contributor is about using an LLC with real estate. Few seem to know how the form of business relates to real estate investing and even fewer understanding anything more about real estate investing that the title of the subject.

Your decision to buy a single family home for rental is already made. You must now answer the other questions above and one the I listed has to do with the way you hold title to the property. If you pay cash, you can put your property into an LLC or other type of legal entity. If you finance, the mortgage company will want you as an individual to take title.

After the sale closes you can transfer ownership to the LLC or other legal entity. So why use an LLC? Starting with the fact that LLC’s are just one of several types of ownership, I will give you my opinion and say that the LLC form is the best for property. Other agree as this is the most popular type of ownership outside of being owned by an individual.

I will not go into the reasons why the LLC is best at this point since I have fully covered types of ownership and benefits in another blog article which you should read. The article in question is about starting a new business which is likely to benefit you. Just click here and read before going further. You should place your property into a business entity to avoid personal liability.

Create as many LLC’s as you have properties. People will jump to an attorney the they saw on a bus or bill board before they will call you to arbitrate a problem. Protect yourself and create entities that own the properties so someone cannot get to your personal assets.

Running the Numbers

After setting a goal on how much you want to earn, run some test numbers in our financial calculator. Click on the link to the left open the spreadsheet and save it to your computer. You can use this to input data for evaluation. I used an actual house for sale in this evaluation. Click here to see the house which will eventually sell.

Please go to the house on the website by clicking above. There are more where that came from. Check the selection of featured homes and search for others that fit a price range that you have set. If you have not set a price range, read further, this analysis may give you an idea of where to start.

Assuming that the property is priced right at $90,000 and purchased at $89,000, run the numbers using what the listing give as a rental rate of $935 since this was a rental. The rental income is easy to verify, just ask the seller to provide some documentation. There is more work here but we are going with the rental rate as stated for the sake of the analysis.

The following are the results of the analysis. By renting the property for the amount the previous owner had rented it for with a 20% down payment, the Cap Rate is 9.8% and the cash-on-cash return is 16.2%. There may be other expenses to add, you will not know all of those details until you actually get information from the seller. This is a good start and let means to me that this property is worth pursuing.

[Note: The interest rate used in the example may not be available for some types of loans. Rates for straight investor loans are generally near or above 6%. Even at 6% the property above will generate nice cash flow.]

As I mentioned, this article will not go into every questions listed above, your Realtor can help you with several of the items. One area that I did want to mention was location. Most people think that they have to buy a property near where they live. Not true. It’s natural to start looking in the same city or county but that may not be where the best bargains are.

You Are Not Required to buy Locally

Years ago when I was trying to buy everything I could get my hands on, starting in California, property was just too expensive relative to rents. It was difficult to get good returns and the start up capital was too high. I started looking at other states. My search landed me in Las Vegas and the Phoenix area where properties were a bargain compared to California and rents seemed to sustain the purchase price. Las Vegas worked out well.

The Phoenix area turned out to be a problem. Rents were not high enough regardless of the promises that were made to me (at the time I left the research to a colleague who failed to nail down the real numbers). The result was that I bought a new house and after 12 years it is still not paying for itself. The equity has been the saving part of this otherwise it would have been a total loss.

I looked at Texas but the property taxes were 3% and while prices were low it made no sense. So, I left the country on my search and found properties in Spain. Spain worked out well. Since I had already bought out of state and had good property agents, I had no fear of going to another country with real laws (unlike Mexico).

About four years ago, I found my spot for further investing. The Mississippi Gulf Coast. Prices relative to rents were very good. The example above is just one of many. Renting is a risk at any time because you could and will get the bad apple so to speak. That renter who buys a car instead of paying rent. You know the one that does not have a vacuum and causes you to replace the carpet after a one year rental.

People who live along the Gulf coast tend to be better renters. By and large they pay on time and respect the landlords property. I have talked with several people who manage property and who invest in property and they seem to be saying the same thing. Perhaps its the fact that the area is fairly small e.g. 400k people and people in the South tend to know each other. Word would quickly get out of someone was evicted. Even employers may have issues if their employee failed to pay rent.

To sum up this section, feel free to cast a wide net. Go where you can make money. Hire an agent if you can make the numbers work, they charge about 10% of rental income. Consider buying on the Mississippi Gulf Coast, contact me and see what is available.

Gulf Coast Realtors has partnered with KEYLADDER to provide a complete turn-key program for our readers and clients. KEYLADDER will work with you to determine your investing goals. They will then locate an investment property that meets those goals. You decide to move forward and they will help you by creating an entire business for you complete with an LLC and new business entity.

They will help you secure your investment property and through strategic partners insure you get the best property management assistance. Please contact KEYLADDER for more information by clicking on this paragraph.

Please feel free to leave comments and suggestions below.